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Accrual Accounting Explained

This article explains how Startly has implemented its finance/accounting processes to support an accrual method of accounting for your organization. There are two accounting methods in practice for managing the financials of an organization: the accrual method and the cash method.

Accrual Accounting

Accrual accounting is a financial accounting method that allows an organization to record their accounting transactions before receiving or making payments for goods and services.

The general concept of accrual accounting is that economic events should be recognized (i.e. recorded in your financial system) at the time the event (ie. financial transaction) rather than when payment for the event occurs. This method provides a more accurately picture of your organization’s financial position.

For example, suppose a consulting firm has provided $5,000 in services to a customer during the month of October. The contract states that the consulting firm will invoice for services performed at the end of the month. Therefore, the consulting firm sends an invoice to the customer for $5,000 on November 1. The customer receives the bill for services rendered and makes a cash payment to the consulting firm 45 days later (on December 15). Under a cash accounting method, the $5,000 in revenue to the consulting firm would be recognized (recorded) on December 15 when the cash has been received. Under the accrual accounting method, the $5,000 in revenue would be recognized in October (when the services were performed or “earned.” In fact, the consulting firm’s accounting records might look like the following over the time period of October through December:

DateEntryAmountOffsetting EntryAmount
Nov 1Revenue$5,000Accounts Receivable$5,000
Dec 15Cash$5,000Accounts Receivable($5,000)
Accounting Entry Examples

The accrual accounting method is considered the standard accounting practice for most organizations except of small businesses and individuals.

Accounting Period Status and Effective Dates

The Effective Date of a transaction can also be referred to as the effective accounting date–the date of record for when a transaction occurred for accounting purposes. The Effective Date for each transaction in your account is determined by reviewing the following:

  • Transaction Date: the date of record for the transaction. For example, a consultant performed 8 hours of service for a project on October 8. The transaction date is October 8, regardless of when the time entry was recorded or approved.
  • Accounting Period Status: the status of each accounting period determines which accounting period each transaction falls within. if, in the above example, a consultant submits a timesheet with 8 hours of work performed on October 8. Suppose the timesheet is approved by the project approver on October 10, and at that time the accounting period covering October 1-31 is currently open, this transaction will be stamped with an Effective Date of October 8, and will be designated as a transaction in the October accounting period.
  • Approval Date: the date of approval by the organization for a transaction. In the above example, if the consultant waited until late November to submit the 8 hours of work performed on October 8, and the time entry was approved on November 20, and at that time the October accounting period was closed but November was now open, this time entry would be recorded with an Effective Date of November 20 (the date it was approved).

The above examples demonstrate the basic principle of accrual accounting to record the event when it occurred at the time the organization became aware of the transaction.

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